Environmental, Social and Governance (ESG) performance is increasingly used to pinpoint winning stocks, and there is growing interest from mainstream investors in whether companies are managing ESG issues. This gives many companies compelling reason to believe that investors are paying more attention to ESG reporting, yet how companies approach ESG disclosure still varies widely. The question becomes—what kind of information are investors seeking? Our view is that the need goes far beyond merely enhancing communication about ESG branding and performance. It includes identifying issues that are material to investors, such as risk management strategies.
ESG issues—particularly in a turbulent economic environment—represent a growing class of financially material risks. Labor disputes in emerging markets, large scale accidents, governance failures, violations of environmental laws—all of these and more are the types of “shocks” to the corporate system that can dictate whether a company lives or dies, prospers or gets acquired. Why? Because investor perception of a company’s preparedness to deal with the unexpected—and resilience in the face of difficult challenges—affects investment interest and decision making. And ESG risks are hard to predict and may have a significant impact on companies and the stakeholders (employees, customers, suppliers) they depend on to remain profitable.
By most measures, the mere adoption of strong ESG practices has minimal impact on a company’s stock value. However, a positive ESG reputation can add a layer of stock price protection that we call the “ESG halo.” Companies that demonstrate they are prepared for ESG shocks may be in a better position to mitigate these downside risks. ESG disclosure, therefore, can add value, because it helps the company demonstrate that it can manage risks and has the forethought to track ESG performance effectively.
Disclosure on how companies manage their ESG risks is critical, because it can help capture investor interest and establish the long-term value of ESG management. In short, the value of how ESG has been managed is clearest after a crisis has hit. Whether an incident is small and short-term or large-scale and catastrophic, it may not be so much direct losses from the event that erode investor trust as it is loss of confidence in management’s ability to anticipate problems and deal with a situation’s aftermath.
Transparency builds credibility in the marketplace and in the mind of the investor. This is why we strongly recommend a disclosure narrative that goes far beyond the data and focuses not only on traditional ESG metrics but also on openly discussing potential ESG risks that your company faces—what they are, where they might originate, and what they mean to the company. Many ESG risks are the unintended consequences, or impacts, of various activities your company undertakes or is associated with. Then you talk about what you are doing to own and manage the risks—both within the company and in the broader context of your industry and a worldview.
Investors are indeed paying attention, because they believe your company’s ESG performance matters to your stakeholders and that it is essential to manage your exposure to ESG risks. In the end, it is the underlying actions you take to craft and maintain your ESG halo that helps you to create value moving forward.
To learn more, read the article in the latest issue of Deloitte Review.
Deloitte & Touche LLP
Dinah A. Koehler
Senior Research Manager
Deloitte Services LP
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